Jet-fuel Hedging Remains a Tough Call for Airlines

The price volatility of Jet-A fuel makes the market difficult to judge. Singapore jet-fuel prices went from more than $135 a barrel to less than $110 and back in the last six months alone.

Adverse oil prices and cut-throat rivalry have left airlines scrambling to limit losses with the increasingly attractive option of jet-fuel hedging. Although a complex exercise, hedging essentially involves locking in a forward fixed price, allowing an increasing number of airlines to avoid surprises from unforeseen cost fluctuations. Today, jet-fuel hedgers trade contracts in Singapore, Rotterdam, the U.S. Gulf Coast or New York, as well as crude and heating oil or gas oil in London and New York, the two most liquid swaps and options markets.

“Airlines often do not place enough emphasis on fuel-price risk management,” said Michael Corley, president of Mercatus Energy Advisors of Houston, Texas. “It’s their largest unknown cost.”

Estimating the quantity of global fuel hedged is difficult: “Perhaps it’s only one quarter or maybe higher than one third, but it certainly doesn’t approach anywhere near 50 percent,” he added. In seeking price certainty, airlines face dilemmas: the correlation between remotely located jet fuel and global market prices are seldom clear, and poor futures and options liquidity makes exiting contracts difficult. As a result, when hedging, airlines often fail to benefit from falling fuel costs. In fact, in 2009 the Chinese government banned the purchase of crude-oil futures for three years, after an oil price collapse a year earlier resulted in steep losses.

Meanwhile, the Middle East’s status as global “swing” oil producers has aroused suspicion for years. While Emirates denies receiving fuel subsidies, the flag carriers of at least two other Gulf nations appear to enjoy implicit government assistance. “I am not aware of any direct fuel subsidies,” said Corley. “Both [undisclosed] carriers that I have spoken with have said that it is more along the lines of an offset than a true subsidy. If you own two businesses, which somewhat offset each other…wouldn’t you prefer both of them to be profitable simultaneously?

“Due to the nature of the fuel system in the Middle East, much of it is state-controlled,” added Corley. “I am unsure how it will develop. Emirates clearly have a vested interest in developing a benchmark for the region that will allow them to hedge more locally.”

To many in the region, the Dubai Mercantile Exchange represents hedgers’ great hope. “The MENA carrier challenge is that there really aren’t any liquid trading products that would make sense for them to use in terms of jet fuel in region as of today. As the industry matures, I wouldn’t be surprised to see that develop,” he concluded.